New lending rate norms turn banking stocks jittery

In a bid to force banks to transmit policy rates faster, the RBI had sometime back proposed that banks move to the marginal cost of funds method to calculate their base rates to which all lending rates are benchmarked. While the RBI maintained status quo on its rates in its Tuesday policy, it indicated that it will soon come out with the final guidelines for calculating base rates under the new method.

Leading banks, such as ICICI Bank, SBI, Bank of Baroda and PNB lost 1-3 per cent in trade on Wednesday on fears the move would lead to their margins coming under pressure.

Banks are free to set their respective base rates (minimum lending rate) after determining a spread over their total costs, factoring in operating costs, cost of funds and the minimum return on equity they deem adequate. But earlier, banks had the option of using either the average cost of funds or the marginal cost of funds method.

Term deposits make up the bulk of the fund base of banks. When the RBI cuts rates, banks trim rates on incremental term deposits, but older depositors continue to earn higher. Hence, the average cost of funds take time to fall and delay the transmission of the RBI’s rate cuts to borrowers. On the other hand, the marginal cost of funds will fall more quickly and this may force banks to cut rates more sharply, which has been the intent of the RBI all along.

This means that banks’ margins would come under pressure, in a declining rate cycle such as now, as the decrease in lending rates would be higher than the decrease in overall funding cost.

While it is difficult to gauge the full impact of this move at this point in time, it is evident that the net interest margin of banks with a higher proportion of floating rate loans will be more impacted than that of banks with higher fixed rate loan portfolios. At a broad industry level, public sector banks (PSBs) have a higher share of floating rate loans — ones that are linked to the base rate. This is likely to put their margins under pressure.

PSBs are likely to see 7-10 basis points impact on their margins, depending on the extent and the pace at which these banks will have to lower their respective base rates under the new method. Stocks of leading PSBs, such as SBI (1.8 per cent), BoB (2 per cent), PNB (3 per cent), Bank of India (2.5 per cent) and Canara Bank (2.2 per cent) fell on Wednesday. Private banks

Private banks, on the other hand, have a higher share of retail loans (40-50 per cent of their portfolio). Since all non-mortgage retail loans are fixed rate loans, margin pressure is likely to be minimal. HDFC Bank and IndusInd Bank are banks with a higher proportion of fixed loans. Also leading private banks have a high share of low cost deposits (current and savings account), which enables them to price loans more competitively. Hence the impact on the margins of private banks is likely to be lower at 3-5 basis points.

Even so, the steady core performance of these banks is likely to keep them in good stead. The pace of loan growth for private banks, such as Axis Bank and HDFC Bank (23-28 per cent), was much higher than PNB (6.7 per cent) and BoB (7.5 per cent) in the latest September quarter.

The weak credit offtake has led to muted growth in these PSU banks’ net interest income (4-7 per cent) in the past few quarters. This is in stark contrast to the healthy 15-20 per cent growth in net interest income their private sector counterparts, such as Axis Bank and HDFC Bank managed to deliver even in the latest September quarter.